PROTECTING YOUR CLIENT: READING FINANCIAL STATEMENTS WITH ... · Reporting Requirements – CCA/OCA CCA • auditor must be appointed annually • must present findings at annual

PROTECTING YOUR CLIENT:

READING FINANCIAL

STATEMENTS WITH A

CRITICAL EYE

M. Elena Hoffstein

416-865-4388

[email protected]

Jill H. McAlpine

416-218-1514

[email protected]

1

Discussion Topics

Reporting – evolving expectations and responses

Audited Financial Statements for Not-for-Profit Organizations

• Regulatory requirements

• Reporting frameworks

• Key concepts and components

• Selected topics

• Endowments and restricted contributions

• Controlled and related entities

• Communications with legal counsel

2

Reporting – Evolving Expectations and Responses

3

Reporting -

Evolving Expectations and Responses

Expectations:

• Transparency, accountability

• Regulatory and contractual compliance

• Resource allocation, performance and stewardship assessment – financial

management and organizational effectiveness

Responses include:

• CICA – “Improved Annual Reporting by Not-for-Profit Organizations”; new

accounting frameworks and standards; 20 Questions Series; NPO Director

Alerts; courses/seminars

• Imagine Canada – Ethical Code, Standards Initiative, Charity Focus

• CRA – T3010 online & searchable, donor education, new tools

• Voluntary Sector Reporting Awards

4

Audited financial statements

Requirements for an audit

Reporting frameworks

Key concepts

Components of financial statements

5

The Statutory Landscape for Non-Share Capital

Corporations

Governing Statutes

• Part I, CCA

• Part III, OCA

• CNCA

• ONCA

6

Reporting Requirements – CCA/OCA

CCA

• auditor must be appointed annually

• must present findings at annual general meeting;

OCA

• same as above

• Exemption from audit if company not a public company, if income is less

than $100K and all of the members consent to the exemption from audit

7

Reporting Requirements - CNCA

CNCA establishes two different types of not-for-profit corporations:

– soliciting corporations; and

– non-soliciting corporations.

• The type of reporting depends on (i) whether the corporation is a soliciting

corporation or a non-soliciting corporation; and (ii) the level of its gross

annual revenues.

• Must submit financial statements to Director

– A “soliciting corporation” is a corporation which received in excess of $10,000, in a financial year, in the form

of donations from third parties, (ie: not members, directors, officers or employees or related persons) grants

or financial assistance from the federal, provincial or municipal government, or donations from other soliciting

corporations;

– A “non-soliciting corporation” is a corporation which is not a soliciting corporation.

8


Type of

corporation

under CNCA

Gross Annual

Revenues (for

previous year)

May Dispense with

Public Accountant

Review

Engagement

Audit

Soliciting Less than or equal to

$50,000

Yes, if all voting members

consent. Members must sign a

waiver annually.

Default, unless the

majority of the

members vote for

an audit.

Optional

Soliciting Between $50,001 –

$250,000

No* Optional Default, unless two-thirds of

members voting for a review

engagement

(subject to the Director requiring

only a compilation report)

Soliciting More than $250,000 No* N/A Mandatory

(subject to the Director requiring

only a review engagement or as

an alternative a compilation

report)

9


Type of

corporation under

CNCA

Gross Annual

Revenues (for

previous year)

May Dispense

with Public

Accountant

Review

Engagement

Audit

Non-soliciting Less than or equal to

$1,000,000

Yes, if all voting

members consent.

Members must

sign a waiver

annually.

Default, unless

the majority of

the members

vote for an

audit.

Optional

Non-soliciting More than $1,000,000 No* N/A Mandatory

(subject to the Director

requiring only a review

engagement or as an

alternative a compilation

report)

10

Reporting Requirements - ONCA

• The ONCA establishes two classes of not-for-profit corporations; public

benefit corporations (i.e. similar to a “soliciting corporation” under the

CNCA) and non-public benefit corporations (i.e. similar to a “non-soliciting

corporation” under the CNCA).

• Charitable corporations are automatically considered to be public benefit

corporations.

• A non-charitable corporation will be considered to be a public benefit

corporation if it receives more than $10,000 in a financial year in the form of

donations or gifts from persons other than its members, directors, officers or

employees, or in the form of grants from the federal, provincial or municipal

government or agency thereof.

• No requirement to file financial statements with Ontario Ministry

• Financial statements much be provided to Public Guardian and Trustee if

corporation is a charity and is operating in Ontario

11


Type of Corp/Gross Annual

Revenue (GAR) of ONCA Corporation

Requirements for an auditor Audit/Review

Engagement

Public Benefit

Corporation (PBC) with

GAR of =

Less than $100,000 (s.

76(1)(b)

May, by extraordinary resolution*

(80%), decide not to appoint an auditor

May dispense with both an

audit and a review

engagement by extraordinary

resolution (80%)

Over $100,000 but less

than $500,000 (s.

76(1)(a)

May dispense with an auditor and have

someone else conduct a review

engagement. This requires an

extraordinary resolution (80%)

May elect to have a review

engagement instead of an

audit by extraordinary

resolution (80%)

Over $500,000 (s.68) An auditor must be appointed annually Audit is required

12


Type of Corp/Gross Annual

Revenue (GAR) of ONCA Corporation

Requirements for an auditor Audit/Review

Engagement

NON-PBC

corporation with

GAR of =

Less than $500,000

in annual revenues

(s. 76(2)(b))

May, by extraordinary resolution

(80%), decide not to appoint an

auditor

May dispense with both

an audit and a review

engagement by

extraordinary resolution

(80%)

Over $500,000 (s.

76(2)(a))

May, by extraordinary resolution

(80%), dispense with an auditor

and have someone else conduct

a review engagement

May elect to have a

review engagement

instead of an audit by

extraordinary resolution

(80%)

13

Reporting Frameworks – CICA Handbooks

Type of Organization Reporting Framework

A

c

S

B

Canadian Publicly Accountable Enterprises IFRS (International Financial Reporting Standards

– CICA Accounting Handbook Part I)

Private Enterprises ASPE (Accounting Standards for Private

Enterprises – CICA Accounting Handbook Part II))

or IFRS

Not-for-Profit Organizations that are not

GNFPOs (NFPOs)

ASNFPO (CICA Accounting Handbook Part III

supplemented by ASPE) or IFRS

P

S

A

B

Governments (including school boards) PSAS (CICA Public Sector Accounting Handbook)

Government Business Enterprises (e.g.,

LCBO, OLG)

IFRS

Government Not-for-Profit Organizations

(GNFPOs)

PSAS or PSAS with PS 4000 series (CICA Public

Sector Accounting Handbook)

Other government organizations (OGOs) PSAS or IFRS

14

Is the Organization an NFPO or GNFPO

NFPO (non-government)

– an organization organized and operated exclusively for social, educational,

professional, religious, charitable or any other not-for-profit purpose – members,

contributors and other resource providers do not, in such capacity, receive any

financial return directly from the organization and that is not a GNFPO

GNFPO – same as above except

– may be controlled by the government ,and

– has counterparts outside the public sector (usually in the MUSH sector)

• includes government NFP organizations that currently report using CICA Handbook

(e.g., schools, hospitals, colleges and universities)

• may include organizations that are directly or indirectly funded by the government or

government agencies (but government funding does not necessarily translate into

an organization that is a GNFP)

15

Audited Financial Statements – Key Concepts

• Objective of financial statements

• Benefit vs. cost constraint

• Materiality

• Qualitative characteristics and trade-offs

• Understandability, relevance, reliability, comparability

16

Audited Financial Statements - Components

• Independent auditor’s report

• Statement of financial position

• Statement of operations

• Statement of changes in net assets

• Statement of cash flows

• Notes to financial statements

• Supporting schedules cross-referenced to financial statements (if any)

17

Endowment & Restricted Funds

18

Endowments & Restricted Funds

Audited Financial Statements

Reporting objective

• Ability to carry out service delivery activities in future

• Financial flexibility

• Role of contributions in funding activities

• Management’s stewardship of restricted assets

Details of externally restricted (endowed and other restricted

separately), internally restricted and unrestricted funds

• When

• How much

• For what purpose

18

19

Endowments

• Can be created by a donor either during lifetime (usually evidenced by a donor agreement setting out the terms of the gift) or on death (documented in a will)

• Can be internally created by the Board of a charity

• Involves the setting aside of capital (either cash or assets that are converted into cash and reinvested) in perpetuity

• Income can be expended on charitable programs or can be accumulated (subject to applicable provincial statutes)

20

Restricted Funds

• Endowments are a form of restricted funds

• Terms of restricted funds can require expenditure of the income and capital over a period of time

• Constraints can relate to restrictions on use or restriction as to a specific purpose (scholarship/research in a particular dept for example; real estate to be held for a particular use)

• Written agreement not needed for a court to determine whether donor intended restricted charitable gift. Will consider other written or oral evidence to determine intent such as correspondence, memo of discussions, fundraising material of charity

21

Unrestricted Gifts

• Gift at law to be applied towards the general charitable purposes of a

charity. Not subject to any restrictions by the donor.

• Board may apply towards certain of its charitable objectives and also

redirect the use.

22

Precatory Gifts/Donor Advised Funds

• Non binding requests by donor. No enforceable restrictions although moral

obligation on charity receiving the gift to consider the expressed preference,

desire, request of donor.

• Donor Advised Fund is a form of precatory gift.

• Too much control retained by donor may cause donation to not qualify as a

gift thereby disqualifying it for charitable receipt under ITA.

23

Meaning of Income and Capital

• Many endowment agreements provide for distribution of income

but no right to encroach on the capital.

• Generally no right to vary the agreement retained by the donor.

• Even if capital not to be retained in perpetuity, because of the ITA

rules prior to the 2010 Federal Budget many gifts structured as

gifts given subject to trust or direction that capital or property

substituted therefore be retained for at least 10 years. This

removed the gift from the requirement that 80% of the receipted

gift had to be expended in the subsequent year.

• Income and capital are colloquially regarded as mutually exclusive

terms – fruit/tree analogy.

• Income - earnings, revenues.

• Capital - assets or property that is employed or invested to

generate such returns - includes capital gains.

24

Endowments and Restricted Funds


Definitions for accounting purposes

• Contributions

• Endowment

• Restricted

Financial statements – Presentation and Disclosure

• Restricted fund method

• Deferral method

• Information about externally and internally (endowed and other) and

unrestricted funds recognized in financial statements:

– Accounting policies

– Contributions by major source;

– Not assets

– Restrictions

25


Audited Financial Statements – Deferral Method

Deferral Method

© The Canadian Institute of Chartered Accountants

26


Audited Financial Statements – Restricted Fund Method

Restricted Fund Method


27

Controlled & Related Entities Related Party Transactions

28

Controlled & Related Entities; Related Party Transactions:

Relevance to Audited Financial Statements

Impact an NFPOs

• resources and operations

• sustainability, flexibility, independence

Government & private funders, regulators, creditors, potential partners

• Ministry of Health

Information needs:

• Basic info, relationship, significance, resources, transactions

Structuring organizations and operational arrangements

29

Concerns under the ITA

• Self dealing

• Private benefit

ITA provisions include:

• Designation - charitable organization, public or private foundation

• Designated gifts – non-arm’s length charities – inter-charity gifts

• Non-qualified investment

• Non-qualifying securities

• Associated charities

• Excess business holdings rules


Relevance for Income Tax Purposes

30

T3010 tool for assessing compliance, identifying potential issues &

monitoring, include

• Subordinate to a parent charity (A1)

• Directors/trustees & like officials (T1235)

• Compensation of directors and others (C8)

• Loan-backs (C13)

• Non-arm’s length borrowing, loans, investments (Section D and

Schedule 6)


Relevance for Income Tax Purposes

31

Controlled and Related Entities

Audited Financial Statements - Definitions

Reporting controlled and related entities

• Control: “continuing power to determine the controlled entity’s strategic

operating, investing and financing policies without the cooperation of

others”.

• Significant influence: “the ability to affect [but not control] the entity’s

strategic operating, investing and financing policies”

• Economic interest: the other NFPO “holds resources that must be

used to produce revenue or provide services for the reporting NFPO”; or

the reporting NFPO is “responsible for the liabilities” of the NFPO in

which it has an economic interest

32

Related Party Transactions

Audited Financial Statements - Definitions

Reporting related party transactions

• Related parties: “one party has the ability to exercise, directly or

indirectly, control, joint control or significant influence over the other.

Two or more parties are related when they are subject to common control,

joint control or common significant influence. Two not-for-profit

organizations are related parties if one has an economic interest in the

other. Related parties also include management and immediate family

members”

• Related party transaction: “a transfer of economic resources or

obligations between related parties, or the provision of services by one

party to a related party, regardless of whether any consideration is

exchanged. The parties to the transaction are related prior to the

transaction. When the relationship arises as a result of the transaction,

the transaction is not one between related parties.”

33


Determination of Relationship

Documents and factors to consider

• Governing documents

• Funder agreements

• Licenses

• Loan agreements

• Contractual or commercial relationships (joint venture, joint project,

services agreements; economic dependence)

• International context: family service agreements

Substance over form; factual & de jure

Accounting and tax definitions/interpretations may differ

Importance of dialogue between lawyers & accountants

34

Controlled and Related Parties

Audited Financial Statements: Controlled Entities

Controlled NFPOs:

1. Consolidate (combined financial statements), or Additional details for all

1. Accounting policy

2. Description of

relationship

3. Description of controlled

organization’s: purpose,

intended community of

service, status under

income tax legislation,

legal form

2. Specific disclosure w/o consolidation

• total assets, liabilities, net assets

• revenues, expenses, cash flows

• restrictions on resources

• significant acctg policy differences

• reporting period if different

• significant subsequent events, or

3. Exempt - One of large group, each individually

immaterial

• exempt from (1) and (2)

• disclose reasons for not reporting under (1) or (2)

Controlled FPOs:

35


Audited Financial Statements:

Significantly Influenced Entities & Economic Interest only

NFPOs - Significantly influenced NFPOs - Economic interest w/o

control of significant influence

• Description of relationship • Nature and extent of interest (e.g.,

nature and purpose of assets

flowing to reporting NFPO; or details

of fund solicitation arrangement;

and/or details of responsibility for

liabilities

• Significantly influenced organization’s

purpose, intended community of service,

status under income tax legislation, legal

form

• Nature and extent of economic interest

For-Profit – Significantly influenced

Equity method of accounting for investments & presentation and disclosure as per ASPE

36


Audited Financial Statements: Related Party Transactions

Related party transactions

Required disclosure:

• Description of relationship

• Description of transactions (including nil amounts)

• Recorded amount by financial statement category

• Measurement basis

• Amounts due to/from, terms and conditions

• Contractual obligations separate from other contractual obligations

• Contingencies, separate from other contingencies

37

Controlled and Related Parties – NFPOs

Reporting Decision Tree

Controlled organizations Significantly influenced

Economic interest only

Related party transactions only


38

Controlled and Related Parties – For-Profits

Reporting Decision Tree

Significant influence

Controlled organization

Related party transactions only © The Canadian Institute of Chartered Accountants

39

Communications with Lawyers


Purpose:

•Audit procedure re: litigation and claims

•Assess risk of material misstatement

Lawyer’s letter

•Management: prepares and instructs lawyer to communicate directly

with auditor

•Auditor: sends and receives/assesses

Financial statements – presentation and disclosure

•Contingent losses

•Contingent gains

40

Jan 1978 CBA and CICA approved Joint Policy Statement

(JPS)

• Two issues addressed:

– protect solicitor-client privilege

– ensure lawyer does not become involved in joint undertaking with auditor in preparation and certification of clients financial affairs

• Memorandum accompanying JPS highlights the following features of JPS

1.Lawyer response is determined by what is found in his records. No direction as it how such records are to be kept or what information is to be found in them

2.Distinction between claim and possible claim is important.

3.Not mandatory for lawyer to respond in accordance with the form letter but it is recommended that they do so

4.When lawyer does adopt the procedure laid down in JPS he/she obliges self to draw attention to claims of which he has record even though not mentioned in enquiry letter and to participate in conference with client and auditor if required.

41

Solicitor Client Privilege

• a key goal is protection of the privilege

• since 1978 Courts have adopted broader concept of solicitor-client privilege.

• Philip Services Corp (Receiver of) v. OSC (2005)77 OR (3d) 209

• “preservation of privilege is paramount and court should not interfere with this more than is absolutely necessary”

• Case involved production of legal opinions that had been provided to auditor when he attended audit committee meeting

• Even though privileged documents are provided to auditor they are so provided for limited purpose to enable the auditors to comply with the full scope of their audit standards. Waiver of privilege can be narrow

• However also recognition that accurate financial statements are also in public interest.

• In cases where law firm knows client has omitted possible claim from enquiry letter lawyer should discuss with client to enable client to make proper disclosure

• Where law firm disagrees with client evaluation of a particular claim law firm should raise issue with client and ask client to arrange call with auditor

42

Solicitor Client Privilege

• What if client refuses to arrange conference or what if law firm becomes

aware of error and advises client? JPS silent. However as a lawyer cannot

waive the privilege, is prohibited from raising the matter with the auditor

without client consent – privilege is that of the client

• If law firm believes that in non disclosing to auditor, client is acting

dishonestly, fraudulently or illegally – Rules of Professional Conduct impose

on law firm “up the chain” reporting or it may be law firm must withdraw from

representing client

• JPS currently being adapted to respond to IFRS. There will be different

accounting frameworks reporting standard for contingencies will change.

• In meantime Interim Guideline has been prepared which is intended to

enhance JPS to assist lawyers in advising clients now following IFRS and to

bridge gap until revised JPS comes into effect.

43

Disclaimer

This handout and the corresponding presentation are for general

information purposes only. They do not constitute a legal opinion or

other legal advice. Readers are advised to consult a lawyer to obtain a

legal analysis and advice before making a decision or taking other

action regarding a specific matter.

44

THANK YOU

M. Elena Hoffstein

416-865-4388

[email protected]

Jill H. McAlpine

416-218.1514

[email protected]